Meaning of Depreciation:

Depreciation is the gradual and permanent decrease in the value of an asset from any
cause. It has been defined as the diminution in intrinsic value of an asset due to its use
or lapse of time. Pickles has defined it as the permanent and continuing diminution in the
quality, quantity or value of an asset.

The American Institute of certified public accountants has defined Depreciation

accounting as “System of accounting which aims to distribute the cost or other value of
tangible capital assets less salvage ( if any) over the estimated useful life of the asset in a
systematic and rational manner”. It is a process of allocation and not of valuation.
Depletion:
Depletion or exhaustion refers to the reduction in the workable quantity of a wasting asset.
For example, a forest gets depleted when timber is constantly used. Similarly a mine gets
exhausted when the mineral contents are extracted and a time comes when it becomes
valueless. This kind of loss is called depletion or exhaustion. Unlike depreciation, which
is gradual, depletion is in steps and is not uniform over different periods.
Obsolescence:
Obsolescence represents loss in the value of an asset on account of its becoming obsolete
or out of date. Due to technological improvements or market changes production within
existing machine may become unprofit- able. The loss arising due to these factors is
known as “obsolescence”. It differs from depreciation in that it is a sudden loss while
depreciation is a gradual loss.
Fluctuation:
Fluctuation is a temporary variation in the market price of an asset due to the operation
of the forces of demand and supply. The main points of distinction between depreciation
and fluctuation are as follows :

Depreciation
1. Depreciation is the permanent fall in
the book value of an asset.
2. Depreciation is concerned with
the book value of an asset.
3. Depreciation always represents a
fall in the value of an asset.
4. Depreciation is concerned with the
fixed - assets.
5. Depreciation is due to wear and
tear, efflux of time, obsolescence
etc.
Fluctuation
1. Fluctuation is the temporary variation
or change in the market value of an
asset.
2. Fluctuation is concerned with the
market value of an asset.
3. Fluctuation may represent either a
fall or rise in the value of an asset.
4. Fluctuation is concerned with
the floating assets.
5. Fluctuation is due to the operation of
the forces of demand and supply in the
market.

Causes for depreciation :

The following are the causes for depreciation :

(a)Wear and Tear : When an asset is used it gets worn out. Its parts get loose or broken.
Its production capacity or usefulness get reduced. Eventually it may become scrap.
(b)Effect of time : Certain assets like lease, patents or copy rights lose their value owing
to passage of time.
(c)Depletion : Valuable contents of an asset like mine or quarry get reduced as their
resources are extracted year after year and in course of time the entire asset becomes
valueless.

(d)Obsolescence : Due to technological advancement an improved model of an asset is

invented making old one uneconomical. So it has to be discarded resulting in loss.

(e)Accident : When an accident occurs and an asset is damaged or destroyed its value
gets reduced or lost.
(f)Permanent fall in the market value : If the market price of an asset falls on a
permanent basis there results a corresponding decline in the value of the asset in use.

Objectives of Depreciation:
Depreciation is provided for serving the following objectives :

1.For proper determination of profits. When business is carried on by using an asset

such an asset gets depreciated. Naturally the loss owing to depreciation should be set off
against the income in order to determine the true profits.

2.For ascertainment of cost of Production. Depreciation is as much an item of production

expense as wages, rent etc. though not visible. Hence for the correct ascertainment of
cost of production depre- ciation should be taken into account.
3.For replacement of Assets. Providing depreciation ensures that amount required for
replacement of an asset at the end of its useful life is made available without causing
any strain on the finance of the business.
4.For meeting legal requirement. In case of Joint stock companies providing for
depreciation is a statutory requirement before declaring dividend.
Factors to be taken into account while calculating depreciation :
The following factors are to be taken into account while providing depreciation
(a)original cost of the asset.
(b)The estimated scrap or residual value of the asset.
(c)The estimated life of the asset.
(d)The chance of the asset becoming obsolete.
(e)The statute governing the provision of depreciation viz, the companies Act and the
Income tax Act.
(f)Sometimes the interest that could have been earned had the money spent in acquiring
the asset been invested in interest bearing securities is also taken into account.

Methods of Depreciation:
Depreciation can be recorded in the books of accounts by two different methods :
(a)When a provision for depreciation account is maintained : Under this method the
amount of deprecia- tion to be charged in a particular year is debited to profit & loss
account and credited to provision for depreciation account. The asset account appears in
the books at original cost.
(b)When provision for depreciation account is not maintained : Under this method the
amount of depre- ciation is debited to the depreciation account and credited to the asset
account. The asset account thus appears in the books at written down value.
Methods of Providing Depreciation:
The various method of providing depreciation are as follows :
(A)Uniform charge method :
(i)Fixed Instalment method. (ii) Depletion method. (iii) Machine hour rate method.
(B)Declining charge method :
(i)Diminishing balance method. (ii) Sum of years digits method.
(iii) Double declining method.
(C)Other method :
(i)Group depreciation method.(ii) Inventory system of depreciation.
(iii) Depreciation fund method. (iv) Insurance policy method. (v) Annuity
method.

(A)Uniform Charge Method

(i)Fixed Instalment method :
Under this method, the assets are depreciated at a fixed amount through out its life span.
The amount of depreciation is calculated by dividing the value of an asset by the number
of years of the estimated life of the machine. At the end of its life, the value of the asset
will become zero. This method of depreciation is followed where the services rendered by
the asset is uniform as in the case of furniture. The following formula is used for
calculating depreciation.

Origina1 cost – Estimated scrap va1ue

Depreciation = --------------------------------------------------
Life of the asset in number of years

Advantages :
(a)It is simple to understand and apply.
(b)It is possible to reduce the value of the asset to zero under this method.
(c) For assets whose life is definite and assets not requiring much of repairs and maintenance, this method
of depreciation is ideal.

Disadvantages :
(a)This method is not suitable for assets which require considerable expenditure on
repairs and mainte- nance.
(b)This method ignores the degree of usage, age and efficiency of the asset.
© This method ignores interest on the amount invested in the purchase of the asset.

DIMINISHING BALANCE METHOD OR WRITTEN DOWN VALUE METHOD OR

REDUCING BALANCE METHOD.
Under this method the depreciation is calculated every year on the diminishing
value of the asset. For example, suppose the original value of asset is say Rs.
10,000 and the rate of depreciation is say 10 per cent. Then according to this
method the asset will be depreciated by Rs. 1,000 in the first year. The diminished
value of the asset in the second year will become Rs. 9,000. Then the depreciation
for the second year will be charged on 9,000 which works out to Rs. 900 and this
practice is continued till the end.
Advantages :
(a)For assets like machinery which requires increasing expenditure by way of
repairs and maintenance as the assets advance in age this method is the most
suitable. This is because while the amount charged by way of depreciation
gradually declines the amount charged by way of repairs gradually increase so
that the combined charge on the profit by these items will be more or less the
same This makes comparision of profits between different period meaningful.
(b)This method is simple to understand and easy to follow :
Disadvantages :
(a)The amount of depreciation charged differ from year to year.
(b)It is not possible to reduce the value of the asset to zero.
 Problems on straight Line Method:
Problem 1. A company purchased a second hand plant for Rs. 30,000. It immediately
spent on it Rs. 5,000. The plant was put to use on 1-1-1990. After having used it for 6
years, it was sold for Rs. 15,000. You are required to prepare the plant account for all
the six years providing depreciation at 10% p. a. on original cost.
Machinery Account

Date Particulars Amount Date Particulars Amount

Problem 2. A trader purchased a machine on 1st January, 1990 at a cost of Rs. 50,000. It
was estimated Rs. 5,000 as its scrap value and the life of the machine for 5 years. On 1st
January, 1992 the machine was sold at Rs. 30,000 and another machine of the same type
was purchased at a cost of Rs. 25,000 on that day. The scrap value of the machine was
estimated at Rs. 3,000 and the life of the machine was 10 years. The installation cost of
1st and 2nd machine were Rs. 5,000 and Rs. 1,000 respectively. Show the machine a/c
and depreciation a/c for 1990, 1991 and 1992.
Machinery Account

Date Particulars Amount Date Particulars Amount

Problem 3. A company whose accounting year is the calender year, purchased on 1st
April 1992 machinery costing Rs. 30,000.
It purchased further machinery on 1st October 1992, costing Rs. 20,000 and on 1st July
1993 costing Rs. 10,000. On 1st January 1994, one-third of the machinery installed on
1st April 1992 became obsolete and was sold for Rs. 3,000.

Show how machinery account would appear in the books of the company if that
machinery was depreci- ated by fixed instalment method at 10 percent annum.
Machinery Account

Date Particulars Amount Date Particulars Amount

 Problems on Diminishing Balance / WDV Method
Problem 1. On the 1st January 1992, a limited company purchased a machinery for Rs.
12,000 and on 30th June 1993 it acquired additional machinery at a cost of Rs. 2,000.
On 31st March 1994, one of the original machines which had cost Rs. 500 was found to
have become obsolete and was sold as scrap for Rs. 50. It was replaced on that date by a
new machine costing Rs. 800.
Depreciation to be provided @15% p.a. on the written down value. Show ledger accounts
for the first three years.
Machinery Account

Date Particulars Amount Date Particulars Amount

Problem 2. X & Co., purchased a machine for Rs. 60,000 on 1st January 1994. On 1st
July, 1995, X & Co., sold the machine for Rs. 45,000 and purchased another machine
for Rs. 80,000. X & Co., charged depreciation @ 15% under diminishing balance method.
The accounts of the business were closed every year on 31st December.
Short the Journal entries for 1994, 1995 and 1996 in the books of X & Co.,
Machinery Account

Date Particulars Amount Date Particulars Amount

Question Papers Problems:
1.

Machinery Account

Date Particulars Amount Date Particulars Amount

2.

Machinery Account

Date Particulars Amount Date Particulars Amount

3.

3Machinery Account

Date Particulars Amount Date Particulars Amount

4.

Machinery Account

Date Particulars Amount Date Particulars Amount